The Fall of the DSCR Loan

Products Exist to Solve Problems.

It is well documented that problems exist in the real estate market and some believe more pain is on the way. Financing is particularly important to all segments and perhaps the biggest liability at the moment. With commercial loans beginning to reset to current interest rates, many fear a wider market downturn is inevitable. But with more problems come more solutions.

Recently we wrote about the emergence of the DSCR Loan — or “Debt Service Coverage Ratio” Loan — a program hailed as a solution for investment property financing. The idea is to sidestep tedious underwriting by instead qualifying the loan based on the projected cash flow. As with all things that seem to good to be true, it is important to do your due diligence. Having recently gone through the underwriting process for a DSCR loan, I can now share more detailed feedback and more importantly vent my frustrations with the process. So, what’s the Catch?

Imperfect and Impersonal

Most companies I have found offering DSCR programs are not big banks with polished workflows and procedures, nor are they small lenders offering that touch of personal service. Instead they seem to combine the worst of both worlds: the impersonal communication of dystopian big tech mixed with the attention to detail of a podunk thrift store. Think long, poorly formatted email templates as a substitute for human dialogue; eight or nine people CC’d on every email, only two of which have ever responded (except to say “out of office”); and responses that say “Looping you in” just to add more arbitrary email addresses to the chain. It makes me shudder. But equally frustrating were the mistakes made along the way.

Hard Money Attitude

When lending is tight, lenders hold a lot of power, and often those with power do not exert much energy toward problem solving. Instead, they are content to sit back and let the stakeholders do the heavy lifting. I cannot speak for all but this was certainly my experience. I felt like the transaction coordinator for my own transaction, and spent literal hours tracking down answers the lenders needed, but were unable to gather themselves. They constantly set up new hoops to jump through — not just for myself as a buyer but for the seller, the title company, and the eventual property manager. Some of the largest hurdles were not requested or disclosed until we were too far into the process to turn back. This may have been by design. They did however provide exceptions for the more egregious requirements, perhaps because they themselves knew how outrageous their requests were.

“Preferred” Vendors

In many states it is illegal to force the buyer or seller to work with a specific vendor. These folks certainly toed that line. I felt totally strong-armed by the lender’s insurance and title company requests. The excessive and inflexible insurance policy required for the loan was not able to be met by any of my three brokers without doubling the cost of the policy. Meanwhile an email offer from their preferred insurance vendor showed up unsolicited in my inbox (actually, spam folder) as the lowest price and best option. The title company I had already chosen (and worked with in the past) was subjected to a humiliating “vetting” process and had to provide personal resumes and bank reference letters to prove to my faceless corporate lender that they were not operating out of a car. It seemed tedious by design, implying that things would go a lot smoother if you worked with their “preferred” vendors instead of your own.

Property Management Subordination

At the 11th hour the lender requested that my eventual property manager sign a contract with the lender to subordinate their fees to the loan payments in the event of default. This was a deal breaker at face value, and I told my property manager that in her shoes, I would not sign that contract either. The lender is not a party to my agreement with my property manager, and has no right to dictate the property management agreement to the property manager. By the time I called the lender back to protest, he was already working on the “exception” for the policy, more evidence of their own awareness of their highly questionable strong-arm tactics.

Underwriting is Still Tedious

The promise of simple underwriting faded quickly amidst the circumstances mentioned above. I do think the volume of personal data requests was less than conventional financing, but the process was still pulling teeth, especially with an underwriter that operates a Slack channel better than a telephone. Piecemeal interaction has left me with 64 emails in just over a week, including the ever reliable request for information already provided, and the inevitable follow up to revise value downwards. Worse still, the lender seemed to have no idea where we were in the timeline and no ability to foresee what other documents were needed to complete the deal. They did not even know the deadline for the financing contingency, and only on that date did they realize how far short the file was. It was a miracle that the deal closed on time, or at all, and was without a doubt the worse underwriting process I have ever experienced — even worse than those that failed.

In the long run was it worth it? I was able to sidestep DTI limitations to acquire another property that promises to financially return far more than the emotional cost of a miserable escrow. But a parting word of caution for all.

Things move fast in the world today. People sometimes create problems just to sell solutions, and certainly hide problems within the solutions they provide. Try not to be a pessimist, but do not be naive: the optimist loses his lunch money but the pessimist has no friends.

Do your due diligence.